California’s carbon market: Will cap-and-trade work?


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Nine months before California is set to finalize a trading system aimed at curbing greenhouse gas emissions, participants have the jitters.

Litigation threatens to delay the start of the multibillion-dollar program, and industry executives worry that its regulations will fall short of guaranteeing a smoothly operating market. Fear is growing that it could be susceptible to the fraud that has plagued a similar European system.


“It feels as though the sun has risen in the West,” Henry Derwent, head of the Geneva-based International Emissions Trading Assn., told traders, bankers, entrepreneurs and oil and utility executives in Los Angeles last week.

“But however tempting it may be … to celebrate getting out ahead of the rest of the United States,” he cautioned, California’s trading system must show “real momentum.... If the program goes poorly, if the regulations don’t allow for a functioning market, there may be little market for California to lead,” Derwent said.

Scientists say that carbon dioxide and other gases, mainly from fossil-fuel burning, are trapping heat in Earth’s atmosphere. leading to dangerous climate change, including rising sea levels, longer droughts, floods and melting glaciers.

In 2006, California passed the nation’s most comprehensive climate law, mandating a cut in carbon pollution to 1990 levels by 2020 — about 10% below today’s emissions. Although Congress balked at similar legislation in 2009, California has moved forward. Its plan to cap greenhouse gases at 600 industrial plants and allow companies to buy and sell emissions permits is modeled on Europe’s 6-year-old cap-and-trade system.

The 700 executives who signed up for the Navigating the American Carbon World conference last week included officials from Alcoa, Chevron, General Electric, Shell, Southern California Edison and other major companies. They were joined by financiers from Merrill Lynch, Deutsche Bank, Morgan Stanley, Barclay’s Capital and other large Wall Street firms.

Engineers and entrepreneurs manned booths and handed out shiny brochures to promote companies that verify carbon emissions, manage greenhouse gas data, broker credits and develop offset projects such as systems to control methane from farm manure or increase forest carbon sequestration.


The European system, which covers 12,000 companies in 30 nations, traded $123 billion in carbon allowances last year and is on target to slash emissions by 21% below 1990 levels over the next decade. But the market has been jolted by an estimated $6 billion in tax fraud schemes along with the recent cyber-theft of $50 million in carbon credits stored in the Czech Republic registry. Today, “the eyes of the world rest upon this [California] market,” said Tom Lewis, chief executive of Green Exchange, a consortium of Goldman Sachs, Credit Suisse and other banks and brokers. Noting the “fraud and violations” in Europe, he added that California could be an example for the U.S., but “the criticism … will be abundant if we get it wrong.”

Carbon-intensive industries are also concerned that California might not provide enough ways for them to offset their emissions by purchasing credits. Although air officials have adopted rules for crediting U.S. forestry and livestock and the destruction of ozone-depleting chemicals projects, they have yet to approve rules for projects such as cutting methane from coal mines or rice farms.

California’s program would be North America’s biggest carbon market, three times larger than a utility-only system in 10 Northeastern states. By 2016, about $10 billion in carbon allowances are expected to be traded through the California market.

A court decision last month temporarily halted California’s cap-and-trade program after local environmental groups contended the California Air Resources Board failed to analyze alternatives to trading. The decision is expected to be appealed, but any delay in the January start date could throw a wrench into the financial planning of hundreds of companies.

“There’s some uncertainty around when this program is going to start and maybe if it will ever start,” said Graeme Martin, a Shell Energy official.

Air Resources Board Chairwoman Mary D. Nichols told the conference that “our ability to move forward is threatened as a result of litigation. We don’t know how it will turn out.... Some segments of the community, who define themselves as environmental justice groups, just hate cap-and-trade” because they believe it would not cut pollution in their communities.


“We have to be open to the possibility there could be other approaches and that we could achieve [carbon] reductions in a different way,” Nichols said. She added that Democratic Gov. Jerry Brown, who met with European Climate Commissioner Connie Hedegaard last week, “has the opportunity to put his mark on it.”

The trading program, seen as a way for industry to cut costs, was incorporated into the 2006 law by former Republican Gov. Arnold Schwarzenegger. Six other U.S. states that had joined with California in the Western Climate Initiative in recent years have declined to participate in its trading program. Three Canadian provinces have indicated they will join.

“The way forward lies in individual regional, national and state systems over the world reaching out to each other over time,” Derwent said, given the failure of the United Nations to negotiate a new global climate treaty.

California’s success, he added, will determine the eventual fate of carbon trading in Congress: “Washington needs to have evidence from California that the solution being applied here works.”

China, Australia, Brazil and several other nations are considering cap-and-trade systems. And Chinese initiatives in particular were the talk of last week’s conference.

Veronique Bugnion, chief of analytics at Point Carbon, a research firm, noted that China, which has surpassed the U.S. as the world’s largest carbon emitter, plans to launch a trading market in six regions by 2013, with a goal of adopting a national program by 2015.


A cap-and-trade market, which sets a price on carbon emissions, is seen as an economic incentive to replace fossil fuel-powered plants with solar, wind and other renewable energy facilities. “The race for a cleaner and more energy-efficient future is on,” Bugnion said. But unless California regulations “put a smart price on emissions, a price people can use to plan for new facilities, a price companies can rely on to innovate … China will eat California’s innovation lunch.”


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PHOTO: Valero’s Wilmington refinery, near the Port of Long Beach.The company, which helped fund an unsuccessful 2010 ballot initiative to delay AB 32, California’s global warming law, owns refineries that would be subject to the state’s cap-and-trade system.Credit: Christina House /L.A. Times